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Indications of dismal sales during the critical Christmas trading period at many UK retailers have highlighted the potential for pain for private equity firms invested in the high street.

The question is whether the banks will lend

Stewart Binnie, Augusta & Co

Private equity firms have enjoyed a bull run in the sector for several years. Acquisitions and exits have grabbed the headlines, allowing investors to bank big profits. Advisers and practitioners are wondering if the good times are over.

Stewart Binnie, a partner at advisory firm Augusta & Co, is also chairman of Baugur-owned Oasis Retail Group. A career retailer, he became a partner at Schroder Ventures and co-advised Permira alongside Goldman Sachs on its aborted bid for WH Smith, the UK retailer.

Binnie said: “Most private equity investors would declare themselves quite satisfied. The issue for them is how the banks react to the present consternation. It is an issue for future deals, not the deals done in the past and not for exits to come. The question is whether the banks will lend.”

Proof of the resilience of the sector came two weeks ago when Financial News revealed the preparations of the private equity owners of Debenhams to relist the UK retailer after acquiring it for £1.7bn (€2.4bn) just over a year ago.

The move illustrated a point made by Richard Hyman, chairman of Verdict Research, a retail analysis consultancy. “One of the things that emerges forcefully in a tighter trading period is that every retailer is pretty much an individual,” he said.

Debenhams more than doubled pre-tax profits to £300m in the year to August 28, 2004. Assuming a tax rate of 30% and the retail sector’s average price/earnings multiple of 14, Debenhams could be worth nearly £3bn if it was floated on this basis, although sales have improved since the year-end.

The same could not be said of J Sainsbury, a potential private equity target.

Justin King, its chief executive, is banking on a revival yet the ailing supermarket group reported a 0.4% fall in like-for-like sales, excluding petrol, for the four weeks to January 1. This was an improvement on the 1.2% fall in the third quarter.

Steven Petrow, partner at Change Capital, the private equity retail specialist, said: “Retailers that try to be everything to everyone are caught in a squeeze. They are neither low-cost nor premium. These are the types of companies private equity will back in 2005: either where the consumer can buy basics, cheaply and conveniently, or where they can buy luxuries with the money they have saved.”

Private equity investments will continue to polarise between retailers like Robert Dyas, the DIY store bought by Change Capital, and up-market chains such as Hobbs, the women’s fashion retailer acquired by 3i last year.

Petrow said only the brave would invest in restructuring the sector’s middle ground, such as J Sainsbury and Marks & Spencer.

“You are swimming against the tide and, as soon as consumers stop shopping, it is tough to turn around. The Christmas results do not change the answer. They just put struggling companies under the magnifying glass.”